When to Consider Going Against the Grain with Your Investments

As investors we must constantly force ourselves to do difficult things and take unpopular positions. In fact, this is the very definition of contrary thinking and investing.

It’s not an easy discipline to master. After all, it’s easier sticking with the comfortable consensus view. There is “safety in numbers,” so it’s said, which is why hard-wired human nature makes it difficult to break from the crowd.

But doing so at key turning points can pay off in tremendous profit opportunities. As just one example, look at investors’ love affair with fixed income …

Record amounts of money flowed into bond funds last year at the expense of equities, according to Merrill Lynch data. At the same time, long-term bond yields fell to microscopic lows with the 10-year Treasury yielding less than 1.5 percent. Of course this flow of funds story is nothing new.

As you can see in the chart above, it’s just the latest chapter in a major asset allocation shift in recent years. After two devastating bear markets in stocks less than a decade apart, the comfortable consensus came to believe that it was best to hide out in the relative safety of bonds.

As if on cue, the consensus once again got caught leading the wrong way last year, as stocks outperformed bonds by a wide margin. Global equities gained 16.8 percent while global fixed income markets were up just 4.9 percent. This was in spite of continued volatility from Europe, a growth slowdown in China, the U.S. election, AND fiscal cliff drama continually impacting markets throughout the year.

This lesson in the value of contrary thinking and investing can be applied to markets in 2013 as well … here’s a current example:

A Bloomberg story caught my eye this week, discussing how fund managers got caught leaning the wrong way in commodities. Here’s the lead: “Traders were the most bearish on commodities since June at the end of 2012 … ”

It seems hedge funds cut way back on their bullish commodity bets at the end of last year, to the lowest in six months. And that was just before commodity prices rallied to a two-month high!

The article went on to explain that net-long positions across 18 commodity futures and options markets dropped to the lowest level since June 19, presumably as big investors threw in the towel on hard asset investments.

My take: The consensus view has grown too pessimistic about commodities. And excessive pessimism can be a bullish buy signal for contrarian investors. That’s why it’s no surprise the S&P Goldman Sachs Commodity Index has quietly moved higher in recent weeks.

In commodity markets where the balance of supply and demand is tight anyway, it doesn’t take much of a sentiment swing to ignite a powerful rally, especially when the crowd is looking the wrong way.

Here are Two PotentialProfit Opportunities for You

Net long positions in 11 agricultural commodities declined 16 percent last week. Then on Friday, the USDA reported a 17 percent drop in corn and soybean stockpiles — a sign of tightening supply and potentially higher food prices ahead. Agricultural commodities zoomed higher across the board on this news including big gains in corn, wheat, and soybeans.

The lesson for you: At times it pays to go against the grain with your investing!

Another commodity where the consensus has become a lot less bullish lately is gold. Net long positions in the yellow metal dropped 13 percent in the week ended January 8, to the lowest level since mid-August 2012.

In fact, bullish sentiment has been falling in gold for six weeks straight. And right after that August sentiment low last year, gold rallied 12 percent higher over the next six weeks … just as the consensus was looking the other way!

From a contrary perspective, this tells me we may be in store for another great buying opportunity in grains and gold right now.

So with that in mind, you might consider keeping your eyes on the iPath Dow Jones Agriculture ETN (JJA) and the iShares COMEX Gold Trust ETF (IAU) for a potential upside breakout.

Good investing,

Mike Burnick

Mike Burnick, who has over 25 years of professional investment experience, is the editor of the Ultimate Stock Options newsletter and associate editor and trader of Martin’s Ultimate Portfolio.

Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also held the position of investment research analyst and Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.

The investment strategy and opinions expressed in this article are those of the author and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.